What are restrictive covenants?

Restrictive covenants are legal provisions used to protect information that is integral to business operations. These provisions can restrict the ability of the leavers of a business from establishing or joining a competing organisation within a specified time period or within a stated geographic region. Since these clauses restrict an employee or shareholder’s activities after leaving a business they are scrutinised carefully when disputed.

Additionally, these restrictions may also prevent the former employee from soliciting or approaching customers of the business by using relationships or knowledge gained during their previous employment. As well as employment agreements similar restrictions may be drafted in shareholder agreements.

Importantly, restrictive covenants are not provided for in terms of common law or statute: accordingly, for an employer to have any form of protection, the required restrictions must be clearly set out in a written contract with the employee. Furthermore, the employer must be able to show that the employee has expressly agreed to be bound by the terms of that contract, which would usually be evidenced by a signed document. Without a binding contract, an employer has very limited rights to restrict what an employee can do post employment. As such, getting an appropriate contract drawn up is key and the starting point to being able to protect the business.

Whether or not a restrictive covenant is enforceable will depend upon whether it protects a legitimate business interest and is reasonable in the circumstances to restrict competition.

When is a restrictive covenant enforceable?

Legitimate Business Interest

A business may use restrictive covenants to protect its interests by restricting an employee’s activities for a period of time after their employment has ended. This will only be enforceable if it protects a legitimate business interest, otherwise it will be regarded as an unlawful restraint of trade. The only justifiable business interests are:

Trade connections, including the relationship between the business’s customers and its staff;

Stability of work force; and

Trade secrets and confidential information.

If the business has legitimate business interests to protect, the restriction will be enforceable against the former employer or shareholder.

Reasonableness

Once the employer has established that a legitimate business interest is being protected, it must then demonstrate that the clause is no wider than is necessary to protect the interest. The reasonableness of the restriction will be determined by reference to the circumstances of the parties at the time the covenant was entered into. Additionally, within this reasonableness evaluation, the court will assess the relative strengths of the bargaining positions between the parties.

The factors which will influence the reasonableness of a clause are:

the duration – shorter and more restricted clauses are more likely to be enforced, with a general 6 month period being the average;

the geographic region – this will be determined on the geographic reach of the business. Indeed, in some cases worldwide restrictions have been found reasonable but this clause should be tailored to reflect the localisation of the business, determined on the size and nature of the enterprise.;

the definition of the business – the employee should be able to fully identify which kind of business they are restricted from undertaking (which must be that of their former employer);

the form of restraint – the court will consider if the restriction is the most appropriate form to impose and if a lesser form is available and could offer similar protection.

What types of restrictive covenants can be applied?

The standard types of restrictions that can be used by businesses are:

Non-competition covenants

These involve restrictions on the former employee working in any capacity for a competitor. Given the stringent restrictions it places on an exiting employee, it is difficult to have this type of restriction upheld by the courts. These restrictions have commonly been justified in order to protect confidential information, however, they may also be used to protect trade connections where the individual has influence over customers or suppliers.

The enforcement of such clauses is assessed depending on the position of the employee they are being enforced against. For example in one case, a 12 month non-compete clause in the case of managing director, who had an intimate knowledge of how the business ran, was upheld.

Non-solicitation

These restrictions prevent soliciting clients/customers/suppliers of the former employer for business. This provision may be justified where an employee holds substantial influence over customers. It requires a specific purpose and intention to obtain trade from customers and must involve the employee initiating contact with the customer for that sole purpose so as to act in competition with the former employer.

Non-dealing covenants

This covenant prevents a former employee from dealing with former clients/customers/suppliers for a given period of time. This restriction may be applied regardless of which party approached the other and does not require the enticement or interference on the part of the exiting employee.

The chances of their successful application of such a clause is more likely where the employer can demonstrate a substantial personal connection between the employee and the relevant customers.

The restriction must prohibit contact which would specifically affect the employer’s business adversely. If the employee is departing to undertake an entirely different type of work then the non-dealing restriction should not limit contact to customers.

Non-poaching covenants

These prevent an employee poaching and recruiting former colleagues. It is essential that these extend no further than is reasonably necessary to achieve its aims. Consideration will be given to how long it will be before the employee no longer has an influence over other employees and the level of seniority of the exiting employee.

How do I enforce a Restrictive Covenant?

If an employer has a reason to believe that an employee has breached such a restriction, the common course of action is to seek an interdict (injunction in England and Wales) before a court. If the application is successful, the court will compel the employee to stop whatever action is requested pending a wider hearing in which more evidence is presented and a more permanent outcome determined.

The court will consider all previously discussed principles and its applicability to the facts of the restriction. Some of the factors which will affect the exercise of the court’s discretion are:

whether the interdict serves a useful purpose;

whether there is sufficient evidence that the restriction has been or will be breached;

the duration of the interdict;

whether the enforcement of the restriction would unreasonably harm any third parties;

whether the damage caused by the restriction can be compensated by damages or some other financial remedy.

The court will need to be satisfied that the employee concerned had access to trade secrets and confidential information or trade connections which warrant this protection.

Additionally, if a previous employee has breached the terms of a restrictive covenant, an employer could also consider claiming damages or lost profits where that breach has caused the business a loss.

Interestingly, as well as the employer being able to raise these types of claim against the departed employee, it is also competent to bring actions against that employee’s new employer. This may provider for a greater certainty of financial recovery where the employee’s departure has caused a significant loss of business.

What do I need to know?

From decided cases it is clear that well-drafted and reasonable restrictive covenants are enforceable and may prove a highly effective tool by which an employer can protect their business against future competition and the misuse of sensitive information of departing employees.

It is good practice that each restrictive covenant is tailored to the exiting employee as, generally, a one-size-fits-all policy risks unenforceability. Indeed, the extent of the clause in relation to the employee’s position within the business will be assessed and restrictions placed on them must not be more onerous than is necessary. In making this assessment, the court may have regard to what the standard practice is in the employers industry – leading to widely different restrictions being upheld in different sectors.

Legal action in this area can involve a substantial investment of time and money and so an understanding of the commercial objectives is essential in matters concerning restrictive covenants to maximise effectiveness.